The Mystery Of The Sleeping Long Bonds

It has been a puzzle ever since the Federal Reserve began raising interest rates in June of last year: Why have long-term rates stayed so low? The Fed has increased short-term rates by 1 1/4 percentage points over the past seven months, with another quarter-point installment expected on Feb. 2. Yet the yield on the key 10-year Treasury note has actually fallen 50 basis points over the same period. By some analysts' reckoning the 10-year yield is 0.5 to 1 point lower than it should be given the state of the economy and the Fed's monetary moves.

In struggling to solve the mystery, analysts inside and outside the central bank have come up with a variety of explanations for the apparent anomaly:

FED CRED: Some 20-plus years of successfully fighting inflation has convinced bond investors that the Fed will do what it takes to keep price pressures in check. What's more, Greenspan & Co. enhanced their credibility by patiently yet persistently raising rates last year despite a temporary summer soft spot in the economy in the midst of a heated Presidential election campaign. "They've built up a lot of goodwill in the marketplace," says Anthony J. Crescenzi, chief bond market strategist at institutional broker Miller Tabak & Co.

A SURFEIT OF SAVINGS: It's not only in the U.S. that bond yields are low. Europe's are as well and have fallen below those of the U.S. That has led former Fed Governor Lawrence B. Lindsey to speculate that a global glut of savings may be holding down long-term rates worldwide. Lackluster economic growth in Europe means hordes of aging baby boomers there have limited investment options for their retirement caches. Some of that money is coming to the U.S., helping to hold down rates here.

ASIAN APPETITES: Led by Japan and China, Asian central banks were big buyers of dollars last year. Their goal: protect their exports by keeping their money from appreciating against the greenback. A quarter of a trillion dollars or more of that money was invested in U.S. bonds, particularly Treasury securities. Fed staffers reckon that lowered U.S. yields by 0.25 to 0.5 percentage points.

STRUCTURAL SLOWDOWN: Some bond investors are convinced that the U.S. economy is a lot more fragile than the Fed believes. Among the troubles they see: heavily indebted U.S. consumers, a federal government awash in red ink, and an overheated housing market. They're buying bonds and bond futures now in a bet that those structural drags will stunt growth this year, pushing yields down further.

Does the rate mismatch matter? If the bond markets are just riding on a wave of Fed cred or retirement cash, probably not. But Asian currency manipulation or drags on U.S. growth could be setting the market and the economy up for an abrupt adjustment. Unfortunately, not even the Fed knows for sure which causes dominate -- or how they'll play out.

By Rich Miller in Washington

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